The Digital Transformation of Tax: How governments are disrupting centuries-old practices and creating a new software megatrend

Hg has been a leading global investor in enterprise resource planning (ERP), tax and compliance software businesses over the past two decades. Having advocated the sector for so long, some may ask why we are so consistent in this space and how much growth potential remains?

We believe this sector is sitting on the wave of a ‘megatrend’, one which has the potential to affect millions of businesses across the world over the next few years. In fact, we believe that tax is now in a position to drive a long-anticipated, wider digital transformation in many core financial technologies, including ERP, cloud procurement and supply chain management.

The evolution of ERP, tax & compliance software

Hg has been fortunate to observe the evolution of ERP software – from on-premise systems, through to hosted and, most recently, to cloud-based ecosystems. During that time, we have also seen how, in many markets around the world, these changes have been linked to government reporting regimes, especially in tax.

Today we believe that we are in the early stages of the next big wave of software growth, driven by government-led innovation of tax enforcement. Long-standing tax audit practices are giving way to forms of continuous compliance where, instead of auditing after the fact, governments are moving tax enforcement to the transaction level.

In indirect tax, including VAT and sales & use tax, some form of continuous compliance already exists in more than 60 countries across the world, including more than a dozen that require real-time compliance checks before a company can sell or ship goods.

This therefore enables governments to record almost all transactions taking place in an economy whilst also allowing them to calculate a business’ tax bill – a process that otherwise takes around two years with more traditional periodic filings. The practice, pioneered in Latin America, has only recently spread to Europe.

“We are continuing to invest in leading ERP, tax & compliance businesses as we believe we are in the early stages of what could be one of the biggest adoption waves for next generation cloud business software: government-mandated, continuous tax reporting and compliance.”

Nic Humphries, Senior Partner, Hg

Continuous Tax ComplianceThe challenges to implement

There are clear advantages presented by the shift to continuous compliance, most commonly seen in indirect taxes, such as “e-invoicing compliance”.

Take VAT as an example. VAT is one of the biggest sources of revenue for governments worldwide. Some 20%-35% of government revenue comes from VAT or similar indirect taxes. However, globally, up to a third of the revenue that should be collected through VAT is often lost to poor understanding of tax laws, error, fraud or evasion.

In the EU alone, the VAT gap, the difference between expected VAT revenues and VAT collected, currently stands at an enormous €151.5 billion per year, demonstrating why continuous compliance is gaining such traction.

But, the reality can prove burdensome for businesses trying to comply with this new reality, with ERP and transactional applications moving from record keeping and administrative roles, to ‘always-on’, business-critical functions.

Imagine; you’re a manufacturer that sells steel to make automobiles. Traditionally, you ship your steel, send an invoice and report the transaction weeks or months later.

Today, in many countries, you now need to first issue an invoice to the customer and the government. Then, you validate that invoice with the government before your truck can leave the factory. The government would then maintain a record of that transaction for audit purposes, setting up a complete reversal in tax data ownership.

As a result, the systems that businesses previously used in order to buy, produce and sell goods are no longer effective and tax software is quickly becoming a critical part of the financial core.

“Whilst the on-premise ERP world was matched with annual paper filings pre-2000, annual electronic filings superseded this approach in the 2000s where hosted ERP software took hold. Now we’re seeing a collision of cloud-first ERP and financial systems and the digital transformation of tax, accelerating the pace of IT modernisation beyond anyone’s previous expectations.”

Jonathan Boyes, Partner, Hg

The Growth Runway – Hg backing the trend

Hg is witnessing this megatrend first hand, originally through its investment in Sovos, a global provider of tax software with c. 1,100 employees worldwide, where we have supported acquisitions in Latin America – the birth place and thought-leaders of this trend – and here in Europe where it has recently taken hold.

“We’re at a tipping point for tax and tax software. Tax has traditionally been one of many considerations in digital transformation initiatives. Now, as tax enforcement becomes part of every transaction, tax is driving digital transformation. And, our customers are investing heavily to make sure their tax software is centralized, continuous and complete.”

Andrew Hovancik, CEO, Sovos, a global provider of tax software with c. 1,100 employees worldwide and an Hg portfolio company

Government-cleared e-invoicing compliance has quickly spread worldwide to more than a dozen countries, overtaking other forms of e-invoicing compliance that exist in more than 60 countries. The real-time standard has set a new baseline for tax enforcement that will shape financial practices for years to come.

“From 1st January 2019, Italy will be the latest country to mandate B2B electronic invoicing, impacting over four million businesses and driving the adoption of next generation Accounting and ERP business systems, especially for the micro/SMB market. We are excited to be seeing a ramp in our growth this year which we think will continue for some time.”

Federico Leproux, CEO, TeamSystem, a leading provider of business software in Italy with c. 1,600 employees and an Hg portfolio company

This regulatory complexity is causing huge strain on IT departments and can require major changes to ERP infrastructure. In fact, 31% of companies report that keeping up with the volume and complexity of regulations is their number one compliance challenge, and 45% say increasing costs of compliance is their number one barrier to growth.

“At Visma, we have well over 100,000 customers who already use the Visma AutoInvoice functionality. This supports real time business-to-government reporting and also helps save businesses people-hours via greater automation in their AP / AR functions. The combined saving on work-hours is estimated to be €40 per invoice. Most important for businesses is that electronic invoices are paid far more reliably than paper-based invoices or PDFs in email. We see a tremendous growth runway ahead of us and the government appears likely to help us accelerate that further.”

Øystein Moan, CEO, Visma, a leading provider of business software in the Nordics with c. 7,150 employees and an Hg portfolio company

Companies that provide software solutions for this issue are therefore in increasingly high demand and Hg is backing this trend. We have invested in more than 100 business software companies across the world over the past two decades and the depth of insight we have been able to gather from doing so supports our conviction that ERP, tax & compliance software are set for a new wave of growth.

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